MCKINSEY LOOKS AT THE COMING EV PHENOMENON

Electrifying cars: How three industries will evolve; Upon entering the mainstream—in a few years or a couple of decades—electrified cars will transform the auto and utilities sectors and create a new battery industry. What will it take to win in a battery-powered age?
Russell Hensley, Stefan Knupfer and Dickon Pinner, June 2009 (McKinsey Quarterly)

SUMMARY
The battery electric vehicle (BEV) is the likely future of personal transportation. It may be years and it may be decades but, as a new paper from noted analyst McKinsey and Company concludes, it IS the future.

Those who think the future is still decades away believe cost will prevent widespread use. For about the next 10 years, the cost of BEVs, both fully electric vehicles (EVs) and plug-in hybrid electric vehicles (PHEVs), will be some several thousand dollars more costly than internal combustion engine (ICE) vehicles. This is due to (1) the expense of designing BEVs, (2) the expense of the battery, (3) bringing production up to mass scales and (4) allowing consumers to come around. Until costs go down and consumers come around, some believe, BEVs will not be a significant market factor.

Those who see BEVs coming sooner expect concerns with energy security, greenhouse gas emissions (GhGs) and car industry competitiveness to drive government interventions (subsidies, taxes and/or investments) that will spur growth.

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The Obama administration has started to do so. Niche markets (delivery and taxi fleets in large cities, some military fleets) are already responding. Israel and Denmark, seeing economic advantage, have begun national programs. China is working and spending to get into the game. The result is innovation and growth in BEV technologies.

The projected industry would be worth many billions in the car and power generation sectors. Those with much to gain and lose are laying plans.

It will be necessary to build an infrastructure to support BEVs. Israel and Japan have already begun building charging and battery swap stations. China’s State Grid Corp announced last fall it will build pilot project charging station networks in Beijing, Shanghai and Tianjin by 2011. In conjunction with U.S. EV startup Better Place, the state of Hawaii will build 100,000 charging stations by 2012.

It will also be necessary to ramp up manufacturing capacity dramatically. China has dedicated new R&D facilities and a $1.4 billion investment to meeting its 2011 goal of putting 500,000 BEVs on its highways. To match that, the U.S. stimulus package allotted $2 billion for battery manufacturing advances and the Obama budget allotted $25 billion for carmakers to retool production lines for building fuel-efficient vehicles.

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The tipping point in the market, McKinsey predicts, will be when 10% of vehicles – 6-to-8 million per year by 2020 – are BEVs. The predicted result would be a dramatic change in whole sectors of the economy, especially the 3 key sectors of autos, batteries, and utilities.

Making internal combustion engines and transmissions has been the core of the auto manufacturing industry for a century. BEVs eliminate both. This puts a burden on automakers who want to make the transition. But it also makes it harder for the new technology to achieve competive manufacturing scale, brand equity, channel relationships like supply chains and dealership networks, customer management, and capital.

BEVs offer opportunities to established automakers, like facilitating the meeting of increasingly stringent emissions standards, the providing of new value propositions to loyal buyers, new utilizations for waning assets and new finance options.

In other words, the question is not only one of consumer response but of automaker response. Will they shrink at the burden of transition or leap at the opportunities? So far, it appears they are leaning toward the opportunity.

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Automakers are now partnered with battery makers as both seek to move the technology ahead and the cost down. Soon the BEV’s entire electronics and software power-and thermal-management system will warrant partnership status and automakers will have to rethink the supply chain model they now use. Car companies could benefit by anticipating this shift and attempting to build these technologies in-house.

Car companies will also need to look at relationships with utilities, gas stations, car dealerships and other third parties. This is known in the auto business as the “downstream.” Recharging infrastructure, for example, will occupy real estate. Car companies might want to consider the investment opportunity.

There could be another opportunity in partnering with utilities in building charging infrastructure. Partnerships could also exist outside the normal dealership relationships with retailers who already sell batteries and electronics. Meanwhile, car companies must recognize that traditional parts dealers and grease monkeys will slowly disappear.

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COMMENTARY
The cost of BEV battrery packs has been going down 6-to-8% per year and is expected to continue doing so with continued aggressive R&D and rising production volumes. The cost now is ~$700-to-$1,500 per kilowatt-hour. Analysts predict it will fall to ~$420 per kilowatt-hour by 2015, not low enough to make the cost of BEVs competitive. McKinsey predicts the cost for a PHEV with a 40 mile battery range will be $11,800 MORE than a comparable ICE vehicle in 2015. An EV with a 100 mile range will be $24,100 more.

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In the same way that the federal government built the national highway system to drive growth of the U.S. auto industry in the 1920s and it expanded the national electrical grid in the 1930s to drive the growth of U.S. appliance and electric commodity manufacturing, federal subsidies will be needed to drive the growth of the BEV industry. China already announced it will refund $8,800 for BEVs purchased by its 12+ city governments and taxi fleets. (See CHINA MOVES ON BATTERY CARS)

IN the U.S., some entrepreneurs are considering something like the power purchase agreements (PPAs) popular in the solar industry to encourage expanded use. Big companies (in the solar industry it’s SunEdison, in the car industry it could be GM Finance) own, operate and maintain the system (solar or vehicular) and charge the possessor a below-market-rate monthly fee for its use (like a lease). The finance company makes its money on the difference between the cost to run the BEV system (which it pays under the terms of the lease) and the cost to run an Old Energy system-powered (gasoline-driven) ICE (just below the cost of which the possessor of the vehicle pays as a lease payment). The assumption is that ICE vehicles will get more expensive while solar power and BEVs will get cheaper.

Will BEVs be cheap enough to win market share? That will depend on the cost of oil (and gasoline at the pump) and of battery and charging costs.

In Europe, where taxes keep gas prices high, a BEV with a 40-mile battery range will be price competitive when oil costs $60 per barrel or more. In the U.S., it will take $4 per gallon gas to make BEVs competitive unless there are substantial federal subsidies.

Another innovative concept is to have prospective BEV owners purchase the car but lease the battery. The car would then be price-competitive and customers would presumably find the purchase arrangement familiar. Owners could buy use of the battery - which would be owned by the car/battery company - according to their driving needs, along the lines of a cellphone contract agreement. This would presumably make the BEV purchaser more comfortable about dealing with the new technology. (See BREAKTHROUGH ELECTRIC CAR FORECAST)

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One of the conundrums of predicting when the coming transition to BEVs will come is understanding the extent to which governments can continue to provide subsidies that undercut the gas tax revenues that fund the present transportation infrastructure. Another is understanding how consumers will react.

Annual battery sales will be ~$60 billion when BEV sales reach 6-to-8 million per year in ~2020. This will move the battery industry into the category of the oil industry and it won’t look back. There are many challenges to getting there.

For now, R&D is being driven by governments. Competing chemistries increase competition but the battery industry can only achieve efficient economies of scale when it settles on a specific technology compatible with all BEV systems and software.

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In this process, battery makers may struggle to legally protect their unique chemistries. A Chinese battery maker has already taken action to protect this intellectual property, spreading the manufacturing process across several factories so the “secret recipe” of the final product cannot be easily known or borrowed.

Legal battles are likely over battery patents. Another legal challenge will be over warrantying batteries. New battery manufacturers may not have the resources to back their batteries. They will have to decide whether to partner on this with car companies or other battery makers with deeper pockets, knowing that whoever they choose could eventually earn equity (and decision-making power) in their company through shared legal burdens.

Ultimately, battery makers may need to partner with other component manufacturers to create a vehicle system, like a steering system. Car makers may try to partner with and then absorb battery technology. The decision about which model to use will likely rest on the availability of capital to finance advances. There may also be opportunities in recycling batteries and making batteries for other forms of transport. Battery makers will need to go where the money is.

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The crucial factor in how the market responds to BEVs could be the utilities. So far, forward thinking utilities appear enthusiastic.

While almost everything about the coming New Energy economy means new headaches and costs for utilities, BEVs also offer the opportunity for more power sales and new business dimensions.

When BEVs represent 20% of any vehicle market, recharging them would be ~2% of power demand. If the vehicles are charged mainly at night, utilities will increase their sales volume without requiring new generation capacity. Utilities could also earn cap&trade marketable allowances from selling power from lower emissions sources that substitutes for gasoline and thereby advertise themselves as environmental stewards.

The key to success for utilities will be getting BEVs to recharge mostly at night because if car owners recharge largely during periods of peak demand, utilities will incur the expense of having to add expensive new generation capacity or risk the threat of grid failure during demand peaks. Driving BEV-chargers to off-peak use will force utilities to spur the development and deployment of Smart Grid technologies.

One calculation proves the point: With 1.8 million BEVs in California in 2020, ineffectively managed charging could cost $5+ billion.

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The exciting part: With the the transition to Smart Grid technologies that electric transport will necessarily entail, Vehicle-to-Grid (V2G) technology will make it possible to use BEV batteries as supplementary storage for intermittent New Energies. That will allow a larger reliance on emissions-free New Energy for all grid supply purposes and, consequently, the more widespread use of New Energy.

Interestingly, this opens a new possibility involving utilities and battery makers. After their expected 10-year use, lithium-ion vehicle batteries, though replaced as unsuitable for BEVs, would likely still be able to hold an 80% charge. It is possible utilities could use the huge numbers of such batteries as massive distributed repositories of New Energy storage. Battery makers would make the ideal partner in such an ambitious and potentially fruitful undertaking, creating a whole new industry and opening further opportunities and uses for New Energy.

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QUOTES
- From the McKinsey report: “Quite apart from electrified vehicles, policies to improve energy efficiency or reduce carbon emissions pose a serious challenge to utilities, whose revenues and profits will come under pressure as businesses, governments, and private homes—stimulated by government investments and by new standards and policies in China, Europe, and the United States—use energy more efficiently. Meanwhile, the utilities’ per-unit generation costs will rise in the near term with the faster adoption of renewable forms of energy, such as solar and wind—intermittent sources that must be supported by a new transmission and distribution infrastructure. Furthermore, any carbon tax or cap-and-trade scheme will affect energy prices and, potentially, the utilities’ long-term profitability…Electrified vehicles, however, create new revenues for utilities…”
- From the McKinsey report: “Electrified vehicles will become a reality—sooner, as the bulls believe, or later, as the bears do. That will change the competitive landscape of the automotive, battery, and utilities sectors and have an impact on several others. Companies that act boldly and time their moves appropriately will probably enjoy significant gains; those that don’t will not. But timing is critical: jumping in too early or late will be costly. Buckle up and hang on for the ride.”